Sizing up the Hydra of local govt debt

Only one thing is certain about the size of local government debt on the mainland: it’s big enough to worry investors. Nobody really knows how much money is involved but the National Audit Office (NAO) put the number at 10.7 trillion yuan in 2010, a figure that many observers believe woefully understates the real situation.

Observers are still waiting for the results of the NAO’s second nationwide audit, which should have come out after the end of the Communist Party’s third plenum last month. But a source said the leadership stopped the report’s release, giving analysts ever more reason to believe the situation is far worse than previously thought.

A Tsinghua University report puts the value of total debt at 19.27 trillion yuan (US$3.17 trillion). According to the report, 9.3 trillion yuan is in the form of bank loans, 5.26 trillion yuan is in social capital leveraged through arrangements like the build-transfer (BT) model and 4.71 trillion yuan is in bonds, trusts and medium to long-term notes issued by entities affiliated with local authorities. Standard Chartered estimates that there could be well over 10,000 of these entities, mainly state-owned enterprises and local government financing vehicles.

Xinhua also reckoned in August, the month when the latest audit was launched, that the total amount could exceed 19 trillion yuan, close to Tsinghua’s figure.

These mounting debts could be an Achilles’ heel for the economy. In its third quarterly report on monetary policy, the central bank admitted that some local governments’ high liabilities were a major threat to sustained development. Other major risks were the real estate bubble and the investment rush.

Debt and investment are deeply intertwined, with the local authorities rushing to launch projects as economic boosters. The BT model of fundraising has emerged as the preferred option for bureaucrats, beating out bank loans, financial leases or trusts and investment funds.

During a random check last year, the NAO found that nine of the 36 local governments, mostly provincial authorities, had built up their indebtedness ratio to over 100 percent, with the highest reaching 188.95 percent. By comparison, Greece’s ratio was 125 percent in the thick of the financial tsunami.

Media reports say debt-laden municipal governments in Nanjing, Shijiazhuang, Tangshan and Shenyang have failed to repay money owed to Metallurgical Corp of China Ltd. (01618.HK, 601618.CN) and China CNR Corp. (601299.CN) for realty and infrastructure projects built on the BT basis. Meanwhile, the Zhuhai municipal government, whose annual disposable fiscal revenue just reached 16 billion yuan last year, signed a 12.6 billion yuan BT contract in September with Metallurgical Corp., the largest such deal so far, to build the city’s new districts.

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